In the past three years, people in industrialized countries have learned anew what inflation means. For example in Germany. Here the management of Deutsche Bahn is negotiating with the railway union from Wednesday on whether a wage agreement is possible in times of inflation without further strikes. The union EVG wants to achieve “that our colleagues earn no less this year than last year”. Coming from workers’ representatives, the statement is not surprising. In fact, however, there is a difficult problem behind the theorem. How does the EVG know how the cost of living will develop this year and next? Everyone tacitly continues the number from the past and the first months of the current year, i.e. about seven percent. Nobody knows whether this expectation is correct. If the European Central Bank (ECB) succeeded in bringing inflation down to two percent, which is its long-term goal, employees would receive an exorbitant increase in real wages, and if inflation were ten percent, real incomes would continue to fall.
Both numbers are unrealistic, but they highlight a fundamental problem. It could also be that the inflation rate remains high precisely because the unions expect it. And not only the unions, but also the ECB and the federal government. Expected inflation could thus become actual inflation.
It’s about expectations. The economist Robert E. Lucas from the University of Chicago researched their role in the economy back in the 1970s. In a succinct 1976 essay, he challenged the then-current doctrine that politicians could choose whether they wanted more inflation or more unemployment. Even today, former German Chancellor Helmut Schmidt is quoted as saying: “Better five percent inflation than five percent unemployment.” Robert Lucas has now shown that this choice does not exist. If the central bank were to print more money to reduce unemployment, then everyone in the economy would do just that. Unemployment would remain where it was, only with higher price levels.
For this research, Robert E. Lucas received the 1995 Nobel Prize in Economic Sciences. His essay from 1976, which went down in the history of economic ideas as the “Lucas critique”, is rightly regarded as a fundamental critique of business cycle policy in the wake of the great John Maynard Keynes. Keynesian models were unsuitable for forecasting and for practical politics because they depended on expectations shaped by those same politics. Lucas was confirmed by the 1980s, when most Western countries abandoned economic stimulus programs and monetary stability slowly returned.
But then came the financial crisis of 2008-2009 and the dramatic rise in inflation during and after the pandemic, which took many economists, including Lucas, by surprise. It didn’t damage his reputation.
Robert E. Lucas was born in 1937 in Yakima, Washington State. As a young man he was particularly interested in politics and on the left. He received his first degree in history from the University of Chicago, transferred to the University of California, Berkeley for a year and then returned to Chicago. There he enrolled in economics for “quasi-Marxist reasons,” as he later put it. He wanted to understand economics, believing that economics drives history, and armed with that knowledge to become a historian.
In fact, he stayed in both economics and, with a brief interruption, at the University of Chicago, which was now influenced by the monetarist Milton Friedman. His second wife, Nacy Stokey, is also a distinguished economics professor in Chicago. Robert Lucas died last Monday at the age of 85.